Don’t Fear the Volatility

We have long known of the media’s – and our own – infatuation with extremes: Best! Worst! Delight! Despair! These sentiments fuel our dreams and inspire works of art. But if you allow superlatives to rule your investing, it could lead to trouble. If you get caught up in reports highlighting the near-term extremes and devaluing the tides of time, you risk losing a clear understanding of what’s really going on.

As we reflect on the events of 2018, here are two points worth repeating:

Average numbers reflect the highs and lows over time, and they are rarely on the average mark each year. Many market pundits concluded that market volatility for 2018 – although sharp and sometimes scary — remained on the low side. Some said that the wilder swings at year-end were not that remarkable in the grand scheme of things. And yet, many outlets have been quick to play up the superlatives, while downplaying how these conditions have long been more the norm than the exception in capital markets.

Warren Buffett has said that the market is unpredictable all of the time. In his famous annual letter to Berkshire Hathaway shareholders, he recently said “The years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur.”

Buffett says that corrections offer the best opportunities, and over the long term, there’s only one direction the market will go. “Successful investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time: You can’t produce a baby in one month by getting nine women pregnant,” Buffett says.

“While stocks can be wildly unpredictable over shorter time periods, they are surprisingly predictable over long periods.” Over decades, the stock market has generated annualized returns of 9% to 10% per year. Since 1965, the S&P 500 has produced annualized total returns of 9.9%, and this includes the dot-com bust, Black Monday in 1987, and the Great Recession. The point: Even the worst crashes can be rendered meaningless when it comes to long-term returns. That assumes of course that your short-term assets, those you need for paying your bills over the next four to five years, are not in the volatile equity markets.

This brings us to the second point.

We are human, and we are susceptible to recency bias.

That means that long-term investing takes a strong stomach. It’s easy to remember the last thing and forget history. While there are many behavioral biases that trick us into sabotaging our best financial interests, recency bias could cause damage in this current bear market.

Recency bias can trick your brain into downplaying decades of robust market performance data, while magnifying the run of unusually calm market conditions we’ve seen since March 2009. This in turn may lead you to put more weight than is warranted to current volatility.

That’s not to say it won’t be stormy and there won’t be more turbulence ahead. But it’s important to remember that extremes are actually the norm, to be able to keep your cool when it gets scary. You stand a much better chance of preserving your objective perspective and your portfolio, based on your goals. If you goals change, that’s the time to make big changes – but not in response to market gyrations.

It doesn’t feel good to see the value of your investments go down. But remember these are paper losses unless you panic and sell in a down market.

Buffett’s attitude toward volatile markets is clear: Don’t fear volatility, and don’t be afraid to take advantage even though it seems as if the world is falling apart.